MONEY MANAGER: The Basic Premise Of Target-Date Funds Is Flawed

Personal finance experts love to debate whether it's smarter to
take on less risk with age, or if they should raise the stakes
when their hair goes gray.

In his paper, "The Glidepath Illusion," money manager Rob
Arnott argues investors would find themselves richer if they went
with the latter.

Arnott pored over 141 years of stock and bond data dating back to
1871 to arrive at this conclusion. He ran a simulation on what
would happen if a woman socked away $1,000 per year, indexed to
inflation, in a fund that started off with a risky mix of 80%
stocks and 20% bonds, then progressed over 41 years to a
conservative mix of 80% bonds and 20% stocks. Arnott assumed she
would start work fresh out of college at age 22 and then retire
at age 63.

If the woman followed this investing "Glidepath," Arnott says,
she "could have finished with as little as $49,940—scant reward
for foregoing $41,000 of spending over her worklife—or as much as
$211,330." Her median portfolio would have been $124,460—not
shabby, but still not ideal.

Next, Arnott tested what would happen if his investor stood the
traditional glidepath strategy on its head, starting off with a
risky 80-20 bond and stocks mix, then gradually moving to 20-80
over the next 41 years. Turns out this strategy would work
out much better for the investor, who would finish with an
average portfolio of $152,060 versus the so-so $124,460.

The investor "would have to accept more uncertainty late in life
as to how much she can spend in retirement—but it's upside
uncertainty," says Arnott, so he concluded "the basic premise
upon which these billions are invested is flawed."

As we've explained before, there's no telling what will happen
with your target-date fund, so it's important to seek advice from
the professionals. What's more, the bigger your portfolio is
later in life, the more money you'll have to bet on stocks. And
more there is to risk means the more there is to gain.

Arnott's simulation isn't precise. He used data from the past,
which can't predict the future, and that overlooks the bull
market since 1982. But if his research proves to be correct,
we'll need to twice about how we're allocating our nest
eggs.